Post-Chavez, Venezuela Enters a Downward Spiral

Beginning in mid-February, Venezuela has experienced a stream of social demonstrations that have left about 30 people dead and hundreds wounded or under arrest, opposition leader Leopoldo Lopez among them. The incidents are being called the largest wave of protests in Venezuela in the last decade.

Much like the social revolts that have occurred elsewhere in the world, students were the first in Venezuela to take their frustrations to the streets. They were later joined by others who were similarly concerned with the country’s high crime rate, galloping inflation and chronic shortages of basic goods. According to the country’s Central Bank, nearly 30% of all products — or their substitutes — cannot be purchased in Venezuela.

These economic problems are not necessarily new — such imbalances already existed when Hugo Chavez, who had led the country since 1999, died of cancer last March. But the challenges have recently become more acute. “Venezuela is much worse off now than it was a year ago,” says Jaime Sabal, professor of financial management at ESADE in Barcelona. “It continues to get worse. Even the poorest sectors that have been benefiting from numerous subsidies and gifts over all these years are now beginning to be affected by economic shortages and other problems.”

Such subsidies created positive results with respect to social projects and social inclusion, “but their success came with a high cost,” according to Juan Carlos Martinez Lázaro, professor of economics at the IE Business School in Madrid. Martinez Lázaro notes that during the Chavez years, the government pursued an economic policy “based on subsidies in order to create a social ‘clientelism’ [a system that depends on patronage relationships, in which officials do special favors for their clients], which has brought the country to real ruin.”

Chavez’s hand-picked successor, Nicolas Maduro, who assumed power after winning a narrow victory in elections last April, has inherited some imbalances that have grown “like a snowball,” says Martinez Lázaro, noting that the situation in Venezuela — with or without Chavez — “would have deteriorated inexorably.”

“Venezuela is much worse off now than it was a year ago. It continues to get worse.” –Jaime Sabal

In many ways, observers say, Maduro’s hands have been tied throughout the year since he came to power. During the first months of his administration, he had to focus on clearing up doubts about his narrow electoral victory. This delayed his ability to make decisions about economic issues. Maduro also inherited the consequences of the previous economic model. However, economist Asdrubal Oliveros of the EFE Spanish news agency notes that Maduro “cannot blame the seriousness of the situation facing the economy” today on the previous administration, because Maduro served as vice-president under Chavez.

Venezuela’s ‘Dutch Disease’

According to Sabal, the current ills of the Venezuelan economy are the product of the irresponsible management of the “Chavista” years — which includes the current government of Maduro. Among the key mistakes made by the government, Sabal notes, are “a growing public debt, which is already too high; excessive public-sector spending, which has been financed by the creation of a lot of currency that has also translated into the current inflation numbers, as well as the risk of extremely high inflation; and exchange controls and unreal price levels that have choked off private-sector activity.”

The lion’s share of Venezuela’s economy has been nationalized, Sabal adds. Under the government of Chavez, numerous companies and landholdings were expropriated, so the problem now is that “their productivity has dramatically declined because they are managed by political criteria.” As an example, he cites the various companies of CVG (Corporacion Venezolana Guayana), which are active in heavy industry, iron ore, steel and aluminum. The conglomerate’s production “has collapsed. And above all, there is PDVSA, the petroleum company, whose production volumes have also been declining; it has been severely indebted and has serious problems of liquidity.”

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Private-sector companies have faced persecution by the government, Sabal says, noting that, in an attempt to control inflation, Maduro issued a decree that lowered the prices of electrical appliances because he accused firms of, in some cases, selling the products at a profit of 100%. According to Sabal, this approach has led “to the gradual withdrawal [from Venezuela] of many companies because they have decided to close down, or because they have moved to other countries. The result has been an almost total dependence on imports in order to keep the country supplied.”

How, despite being one of the world’s largest producers of petroleum, has Venezuela ended up in such a precarious situation? “You have to know how to manage wealth,” says Martinez Lázaro, who notes that Venezuela’s problems reflect “the Dutch disease at its most extreme expression.” (The “Dutch disease” refers to when a country’s over-dependence on exports of primary products pushes up the value of its currency, leading to a downward spiral in its manufacturing productivity and competitiveness.)

Martinez Lázaro says the country has, in recent years, used the income from petroleum to finance its programs for health, welfare and education. “However, national production has been totally deprived of incentives,” he notes. Petroleum has been used to acquire political support from many countries in the region, and in some cases, the country’s petroleum is exchanged for food, he adds. That “has been a brutal burden that the country is paying for today.”

China has been one of the most important sources of support for Venezuela. Today, Venezuela provides more than 500,000 barrels of petroleum each day to China in exchange for foreign financing. One of the more recent examples of that relationship is a new $5 billion tranche of financing from the China-Venezuela Joint Fund. Nevertheless, Sabal says that selling petroleum to China in the future means “additional indebtedness for the country, since a significant part of the production must be sent to [China] to repay the money advanced to Venezuela, without any compensation cash.”

A Cautionary Tale

Venezuela’s mismanagement of its vast energy resources serves as a “very vivid example” of the kinds of mistakes that can take place whenever governments take a short-term, politicized approach to managing their oil wealth, notes Felipe Monteiro, a professor at INSEAD and a senior fellow at Wharton’s Mack Institute for Innovation Management. Monteiro points out that numerous research studies have shown that, whether in Latin America or elsewhere, oil wealth “is a double-edged sword that can have negative consequences unless governments take a proactive approach” aimed at avoiding the pitfalls.

Two kinds of proactive approaches that have proved successful, Monteiro notes, are exemplified by the governments of Norway and the emirates of Abu Dhabi and Dubai. Norway funneled much of its oil-sector surplus into a sovereign wealth fund worth more than $800 billion at the end of 2013. Dubai and Abu Dhabi, on the other hand, have used oil revenues to develop knowledge-intensive capabilities, transforming themselves into regional centers of financial services and tourism. “You can’t use up the money you get from the resource, but you prepare for the future” by diversifying into the development of human resources that last much longer than natural wealth, adds Monteiro.

Oil wealth “is a double-edged sword that can have negative consequences unless governments take a proactive approach.” –Felipe Monteiro

Another way to describe this approach, notes Monteiro, is to distinguish between the various definitions of the word “resource.” While every country’s “natural resources” have value in and of themselves, they wind up having greater worth over the long term when used for “making their countries more competitive, and their industries more diversified — when they are used not as an end in itself, but as a means to an end.”

Numerous nations are “looking around the world for a model” for how to use their resources, especially in South America, where the example of Venezuela seems a lot less remote than it does in the United States, Monteiro says. What will this mean for Brazil, where national oil giant Petrobras and other companies expect to develop the estimated reserves of more than 50 billion barrels in the offshore “pre-salt” region?

The good news for South America’s most populous country, notes Brazilian-born Monteiro, is that although this is a “potential issue for Brazil, the big flow of money from oil is not there yet. Although the money is coming, Brazil still has time to think” through the lessons offered by Venezuela, and make the right choices about how to spend it. “In Brazil, there is a potential gap between knowing and doing. Lots of promises have been made to invest the pre-salt money” in education, health care and other long-term benefits, Monteiro points out. “Will those good intentions be able to resist the short-term temptations” of spending that money on programs that feel good politically, but don’t yield long-term benefits?”

Once again, the Venezuelan example shows “how consequential bad management of governments can be,” says Monteiro. He hopes that this negative example is “so vivid, it will help Brazil to avoid the short-term myopia” that has taken control in Venezuela.

Democracyat Risk?

The economic situation in Venezuela has deteriorated so much that experts do not see any light at the end of the tunnel. Short-term relief won’t come from oil markets, say analysts, because prices are not expected to strengthen soon. Only a wholesale fix might help, and that is unlikely to occur. According to Martinez Lázaro, “it would be necessary to undertake a strong plan for [economic] stabilization, but this is not going to be easy because the current administration has not shown even the slightest intention of giving signals of change. On the contrary. I believe that the imbalances will become even more acute, and that this will lead to an economic crash. The economy is on the road to ruin.”

“I believe that the imbalances will become even more acute, and that this will lead to an economic crash. The economy is on the road to ruin.” –Juan Carlos Martinez Lázaro

Sabal agrees. “Nowadays, there is no margin for maneuvering. The government finds itself facing the dilemma of either further deepening the changes toward a communist-style economy — which means rationing and nationalization of what remains of the private sector – or undertaking a program of change under the auspices of the International Monetary Fund.” He predicts that the reconditioning of the country toward a modern economy, in the style of the Western democracies, will be rejected so long as the current leaders remain in power, simply because of ideological reasons.

On the political side, a solution seems to be increasingly difficult. In a report published by Vanderbilt University’s Latin American Public Opinion Project (LAPOP), co-authors Mariana Rodriguez and Jonathan Hiskey surveyed public opinion in the Americas about whether the level of political unrest being experienced in Venezuela was predictable after the death of Chavez and the election of Maduro. They noted that, given the absence of a charismatic leader such as Chavez, and as a result of the weight of current social and economic problems, the current political instability was inevitable.

This is why, they added, that the poor performance of the Maduro government has destroyed the high level of support for the system that existed under Chavez. In addition, it “has destroyed the pressure valve that used to control the conditions affecting the hostility and tolerance between the [supporters of Chavez] and their enemies.” In so doing, the dominant political culture of the country has gone from belonging to the group of nations characterized as having “authoritarian stability” in 2012 to belonging to the “democracy at risk” category at the start of 2014, the researchers said.

Since the arrival of Maduro, notes Sabal, “a damaging divide has been created in the country about whether or not to accept the importance of the political opposition (who comprise about 50% of the population, according to the last elections), as well as about whether to disqualify all of those people who are not in agreement with the regime. All of this has been encouraged by the language of hatred on the part of authorities.” So much so, Sabal predicts a totalitarian outcome, in the style of Cuban communism or, “even worse, the conversion of Venezuela into a failed state. Only if there were a change in the regime could we begin to think about a different outcome. The problem is that the current leaders seem to have decided to maintain power at whatever cost.”

Beyond the social and economic conflict, Venezuela also faces a crisis of security. In 2013, Venezuela recorded one of the world’s highest murder rates, with more than 24,000 homicides, or 79 killings per 100,000 inhabitants, according to the report by LAPOP. “These current rates of violence are not acceptable, and officials are prohibited from talking about them,” Martinez Lázaro notes. “On the other hand, they are a reality, and no one is able to find a solution.”